Should interest rates go up or down?

The following information was released by the Independent Institute:

By Scott Beyer

Interest rate direction is central to modern U.S. monetary policy, and the last two decades, that direction's been downward. The Federal Reserve drove the federal funds rate to near zero in late 2008, kept it there for seven years, and rates have stayed unusually low through this decade. As the Fed now approaches its December meeting, it's once again weighing the health of the dollar (which demands raising rates) against the loose money policies benefitting the stock and housing markets by lowering them once again. It raises the question of which demographics the Fed really wants to serve.

Low rates have been the rule since the Great Recession; even the 2015-2019 hikes were far below historical norms, causing a prolonged period of loose money, cheap borrowing, surging asset prices and rapid money-supply growth. When COVID struck, the Fed doubled down on this approach, returning rates to zero and resuming quantitative easing. Circulating currency grew around 30% between 2020 and 2022, contributing to the highest inflation in forty years. The dollar, meanwhile, is far from the powerhouse it was in the 1980s, when high rates under Paul Volcker reversed years of inflation, producing both a stronger currency and an economic expansion.

In short: the U.S. has been running an accommodative monetary regime for most of the last fifteen years. That matters now because lowering rates could mean further weakening the dollar and reigniting inflation.

While the causation is not one-to-one, low interest rates have predictable effects on currency strength. When yields fall, foreign investors have less incentive to hold U.S. government bonds, reducing demand for dollars. At the same time, banks can increase lending more aggressively. Modern banks do not simply "lend out" deposits; they create new money whenever they extend credit. Cheaper borrowing therefore means more borrower demand, more credit creation, more dollars circulating in the economy, and more upward pressure on prices.

The Fed has already lowered the federal funds rate twice this year, and prediction markets foresee another cut in December. The stated reason is a softening labor marketslower job growth, rising continuing claims, and a decline in job openings. Proponents argue the Fed is simply adjusting rates to achieve its dual mandate of stable prices and maximum employment.

But there's another, more political, dynamic at workone that's not about inflation or employment, but rather about boosting asset values, particularly in housing and stocks.

Anytime those markets wobbleeven slightlya chorus of voices from Wall Street, the media, corporate America, and elected officials urge the Fed to "do something." And inevitably, the Fed and other federal bureaucracies deliver lower rates and more subsidies for the relevant institutions.

The aforementioned crises are case in point. The 2008 housing crash was met not only with near-zero interest rate drops, but emergency credit facilities used to stabilize mortgage markets. In 2020, when the emerging Covid crisis briefly drove stocks down 30%, the Fed unleashed a wave of liquidity measures that sharply boosted stocks.

Whatever the merits of such intervention in extreme cases, after nearly two decades of these loose conditions, nearly every major asset class is at or near all-time highs. Moreover, thanks to the Fed's loose money precedent, markets are overly-dependent on low rates that boost even slight market dips. Rather than following market signals about scarce or plentiful credit, investors sit around waiting every few months for what is effectively a coin flip.

And this chiefly benefits the wealthy and the old. The top 10% of Americans own nearly 70% of all household wealth, as of 2024, the top 1% alone owned around 50% of all stocks, and Americans over 55 own about 3/4ths of all U.S. stock equity and around 50% of all home equity. Skyrocketing stock and home prices make for good headlines and political wins, but they price these assets out of reach for younger, less-wealthy Americans. Concurrently, the policies that generate high asset prices can cause inflation in consumer goods and services, also disproportionately hurting the young and the poor.

The Fed, itself run by older, wealthier Americans, may not intend to redistribute wealth upward, but the effect is unmistakable. The dynamic, as I've recently noted, explains why younger Americans are skeptical they can achieve the American dream, and are embracing socialism or even more radical redistributionary ideologies.

That's why libertarian economists argue that marketsnot committeesshould determine interest rates and related monetary policies. Savers would earn a real return, borrowers would pay a market price, and asset prices would reflect underlying fundamentals, not the next press conference from the Federal Reserve.

The Fed's unwritten mandate of low interest rates and high asset prices is destructive. It's cronyism that gives Wall Street, Washington, and the already well-off cheap wins while making homeownership and investment harder for younger generations already struggling to climb the economic ladder. A rate cut this December will make it hard not to conclude that the central bank views this unwritten mandate as more important than its low-inflation, high-employment one.

Cover image is available in the public domain.

Scott Beyer

is a Columnist Fellow at Independent Institute. He is the founder and CEO of the Market Urbanism Report and host of the Market Urbanism Podcast.